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April 19, 2021
The past is the past. This is the common refrain among investment professionals looking to put money into a heady market for health and wellness products. The smartest of the bunch are looking forward, not backward, and asking the hard questions about how best to normalize the sales bump attributed to COVID-19. These are questions that then lead to more questions about the reinvestments made by brands during the windfall to create lasting value in 2021 and beyond.
When the final numbers are tabulated, 2020 will deliver double-digit annual growth for the supplement industry (Nutrition Business Journal currently estimates 12%), with specific categories (immunity estimated at 52%) and sales channels (e-commerce estimated at 65%) sure to break records. But that’s old news. “We don’t give a shit about the past,” said one investor on background. “If you’re looking to sell or raise money based on year-over-year performance, that’s already baked into the math. What about the next five years?”
“I think there are a lot of lessons about to get learned,” says Robert Craven, managing partner at Findaway Adventures and former CEO at MegaFood. Findaway works at the lower end of the market with startups raising seed rounds and series A investments. It’s noisy in there. “There’s so much new money in the space,” says Craven, “with new types of investors from Silicon Valley and newly-minted angels from successful exits over the past few years. I think we’re all about to learn that it’s easy to start a business—especially with a toehold in digital—but then it gets real hard real fast.”
“There’s so much activity,” says Mike Bush, co-founder at GrowthWays Partners and former CEO at Ganeden. “When you’re at your highest revenue and EBITDA ever, that’s a pretty good time to sell.” As the full impact of 2020 hits financial statements, experts are seeing—and expect to see even more—interest from brands to capitalize on the good news.
William Hood, managing director and founding partner at William Hood and Company, puts the fervor in context. “Investment and M and A interest in dietary supplements is as high as I’ve ever seen it in my 23-year banking career,” he says. “I would argue that it’s the highest in history. The pandemic has made health and wellness the number one priority for consumers. Period.”
The numbers will certainly bear this out, with industry sales reaching record highs in absolute dollars and annual growth rates not seen since the late 1990s, when that growth was tracked from a much smaller base. During various stages of the pandemic and its quarantines, businesses grappled with supply chain shortages but also saw new customer acquisition costs drop almost to zero as ad rates cratered. Contribution margin earned per sale shot up. Brands shifted from negative EBITDA to full profitability in a matter of weeks.
Courtney Nichols Gould, co-founder and co-CEO at SmartyPants Vitamins, saw it all firsthand, including the recently announced acquisition of her company by Unilever in late November. She also sees continued prosperity ahead. “When I reflect on 2020, we did see more consumer demand and younger consumers coming into the category, but we don’t view COVID-19 as a bump,” she says. “This was an accelerant for trends already occurring in the market, like a drive to quality and a drive to e-commerce.”
In a certain light, she says, the COVID-19 bump could actually work as a deterrent to future deals. “That acceleration of sales with COVID-19 can work for you,” says Gould, “but also against you. Maybe those new sales get discounted by COVID-19. It’s still so fresh that [investors] don’t know yet how to differentiate your brand attributes from the COVID-19 effect.”
A quick, somewhat obvious, consensus opinion: Lots of brands will look to sell in 2021, drafting off the spoils of a COVID-19 bump. But how big was the bump? And how can an investor normalize effectively against it?
“The smart money in private equity has started to roll into the industry more,” says Bush. “They know there’s a bubble, to some degree, so I’m seeing a slowdown coming out of all this.”
Say a hypothetical supplement startup had $5 million in sales going into the pandemic, and that number jumped to $15 million in 2020. And say that company wanted to raise money at eight times EBITDA. What’s the normalization logic that corrects for the anomaly, such that an investor can write a check with confidence that the numbers will prove accurate for the next year or two, in a market not fueled by a raging pandemic? That question hasn’t been answered yet.
Hood has not seen any discounting from COVID-19, and pricing has remained strong, but strategics, especially, are beginning to normalize for a COVID-19 bump.
“If you think of Nestlé or Unilever, these are huge businesses with sophisticated analytics happening every day,” he says. “If they believe a COVID-19 year needs a discount, they’ll bake that into their valuation models. I’m not hearing any talk of discounts, but the strategics are attempting to normalize a COVID-19 bump. Nobody will know how best to do that until we’re 12-18 months out.”
NBJ has heard from contract manufacturers, further up the supply chain from finished brands, that orders are beginning to get pushed as a measure to right-size inventories that ballooned during the early months of the pandemic. If a contract manufacturer saw a hypothetical customer increase its order by 50% in 2020, expectations for 2021 now run toward a 10-15% retraction from last year’s high.
Hood sees the next wave of acquisitions in 2021 and the first half of 2022 landing with the younger companies now reaching scale—say $50 million to $100 million in sales—on the heels of the pandemic. That first wave of disruptors in supplements from the prior decade are effectively sold out. Think of Olly, Liquid IV and SmartyPants going to Unilever; Vital Proteins and Persona to Nestlé; Care/of to Bayer.
“There’s another wave coming,” says Hood. “The number of startups chasing venture capital or private equity is at an historical high.”
Craven knows this all too well. “I’d say that 10-20% of the decks I see now carry outrageous valuations,” he says. “Sometimes they get the valuation, but primarily from investors outside the space who don’t understand the CPG world. This is why 2021 is a year to focus. Wellness is hot. Supplements carry high margins with good e-commerce metrics. And there’s so much dry powder. A lot of dumb decisions will be made in 2021, as brands try to compete out of the gate.”
Gould also sees 2021 as a critical year for supplement brands in a volatile world. “With this level of unpredictability, flight to quality is always the move,” she says. “That means repurchase. With so many new brands launching, that’s the fuel to grow your marketing. How does the saying go—great companies are bought, not sold? You prove that out with customers who buy again and again and again.”
One way for the market to reset after the heady, wild ride of 2020 is to follow the money. How did brands reinvest their profits? What happened last year to create lasting value? Here’s a quick hit on the best ways to answer these questions from sources interviewed for this article.
“2020 was a good year to improve processes, to get the right staff in place and to prep for volatility,” says Bush. “With so much staff sitting around and not on planes, you can do more of the intellectual work and planning that takes time and often gets sidetracked.”
With a successful exit now under her belt, Gould shares similar advice. “When we’re not meeting in person,” she says, “you have to do a good job of organizing to foster that healthy due diligence process. The more buttoned up you are, the better and faster it all goes. We got lots of positive feedback about our data room and how we’d already asked ourselves all the hard questions.”
“This was the year to set up recruitment for clinical studies,” says Bush. “Science should be king in our industry, and with extra revenue and profits there’s more opportunity to prove out that concept. I’d look at spending money on IP and clinical work as much as I’d look at ways to market directly to consumers.”
“There are so many supplement companies with a million SKUs,” says Bush. “Look at a subscription model like Persona or Tespo, where personalized supplements show up on your doorstep every month. That’s a better way to add convenience and compliance. I’ll always stick with convenience, as long as it’s not outrageously expensive.”
With that initial COVID-19 bump in sales, most brands jumped into the fray to meet consumer demand. Now’s the time for some reflection and analysis to parse the bump. “Who bought during the bump?” asks Hood. “Obviously this pandemic accelerated the pivot online toward DTC and Amazon.”
“COVID-19 accelerated the move toward consumer-centric e-commerce by four or five years,” says Craven. “You have to speak social media and digital marketing—with rapid partnering—to get there. The competition online is just crazy.”
“Double down on whatever makes you special,” says Craven, “whether that’s quality, storytelling, or new product development.” Put the money into what’s worked so far to differentiate from the pack.
Hood concurs. “Just because you’re in supplements does not mean you will automatically sell for a big price to a large strategic,” he says. They’re called “strategics” for a reason. “Strategic acquirors are looking for focused brands that fit their approach to health and wellness,” he says. “They want brands that really understand their reason to exist and the reasons they are likely to outpace category growth.”
For larger brands with COVID-19 sales to reinvest, Craven suggests an acquisition strategy. “If you’ve got an extra $10 million, you could leverage some debt and buy two or three little brands,” he says. “There are lots of steals coming as some of these startups run out of money.”
Another way to boost innovation for lasting value? Fund it internally. “The bigger supplement brands should look at creating a skunkworks,” says Craven. “Hire someone who understands agile practices, rent them some office space away from your team, and let them build MVPs (minimum viable products). Turn them loose to study the data and get creative.”
COOs may offer a different perspective. “Anything you can do to make your products higher quality will create value,” says Gould, “but if it were me, I think dry powder is not the worst thing right now. If you’re an independent brand, sock away some cash. The next 18 months is going to be a highly unpredictable environment.”
In defining the COVID-19 bump and resetting to some new normal in 2021, the real debate lies with customer retention post-pandemic. Will the new customers stay? Will they decrease their spend, or downgrade to cheaper products? Sure, but maybe just a little.
“COVID-19 led to a massive period of trial,” says Hood. “Those new consumers have already stuck around to now convert. A growth rate in the mid-teens may not sustain going forward, but we do believe there will be a higher base on other side. Nobody is expecting a massive decrease in 2021 sales.”
That’s especially true in a category like immunity, which, perhaps, has been permanently elevated up the condition-specific totem pole as an everyday health concern. “Everybody is trying to figure out if their products affect the immune system,” says Bush. “That backs off a bit, but it’s really not going anywhere.”
This article was featured in the Nutrition Business Journal Guest Editor Issue. The guest editor was Whipstitch Capital's Michael Burgmaier.
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